Monday, December 23, 2013

Why English Majors (and their editors) Should Take an Economics Class

To avoid writing silly articles, as appeared in the Sunday New York Times under the title "Triumph of the English Major." Gerald Howard, a book editor in New York City writes of an early experience:

I had the idea that we should reissue two early novels by the fine writer Alice Adams...

So there I was in our C.F.O.’s office with a P. & L. that just eked out a 7 percent return. He looked at that piece of paper dubiously....Then, with that wry and sad expression with which financial people have regarded liberal arts people since at least the invention of movable type and perhaps even written language, he signed off on my shortfallen P. & L. and said to me, “You know, we could make more money by just putting this advance into a certificate of deposit.”

I knew he was right...C.D.’s were paying 10 percent per annum or more....

However, as I went back to my office I experienced an instance of what the French call “stair wit.” I thought, wait a minute, I am putting that $7,500 to work. It’s an investment. The chain of activity I am putting in motion will give work to printers and shippers. It will provide bookstores (there were still bookstores) with tangible goods to sell at a profit. The revenue from those sales will help to pay my salary, my colleagues’ salaries, even our C.F.O.’s salary. Alice Adams will have some thousands of dollars in her pocket — maybe to invest in a C.D. All this and a few thousand people fewer than I put down on the P. & L. (I’d lied, of course) will have bought and enjoyed two excellent novels that deserved to be in print.

Whereas if we’d just put that money in the hands of a bank, they would just ... well, I was pretty hazy on what a bank would actually do with that money, but my general sense was that it would sit there in a vault microbially propagating itself and what good would that do anybody? Economically I was putting my shoulder — or Penguin’s shoulder — to the wheel! I came away with the conviction that I wasn’t useless anymore.

This makes a good quiz question for an undergraduate micro class. Make it an essay question, for the English majors. "What's wrong with this story?"

There is a reason for that "wry and sad" expression. The French may call it "stair wit." Or perhaps that was "bêtises d'escalier?" Maybe "fall down the stairs wit?"

Because of course money in the hands of a bank does not "microbially propagate" itself in a way that does no good to anybody. Perhaps I can appeal to literary sensibility with a few song lyrics, explaining what will happen to young Michael Banks' tuppence invested wisely in the bank:

You see, Michael, you'll be part of
Railways through Africa
Dams across the Nile
Fleets of ocean greyhounds
Majestic, self-amortizing canals
Plantations of ripening tea

(Ok, the song goes on to "think of the foreclosures.." but we don't want to get in that here.)

The $7,500 dollars Mr. Howard invested in a book would have been lent out by the bank to someone else, who would have invested it in a better project. Someone might have started a restaurant, or even a bookstore. Every single dollar of goods, every single job created by his investment, would have been created by the alternative, and more.

He just didn't see the (say) new immigrant, turned down on a loan application for $7,500 to start that lifetime dream restaurant. Or turned down on a mortgage application, thus denying a whole construction crew a summer's employment. And the lumberyard its sales and so on. The invisible hand is, alas, invisible.

That is a great strength of the market. It works, even when the people involved don't understand it. Alas, democracy requires voters with some clue.

Oh. And who is this boss who signs off on obviously cooked 7% return projects when CDs were yielding 10? No wonder print media is going down the toilet. And who are the editors who signed off on this piece? I don't write for the Times (I try on occasion, but they always reject me). But at the Wall Street Journal, they tear apart my prose and push every little detail of fact and logic. Do the NYT editors not know that banks do not microbially propagate money?

Mr Howard concludes

...future epochs will remember us as a coarse and philistine people who squandered our bottomlessly rich cultural inheritance for short-term and meaningless financial advantage.

And that is why you should major in English.

I think it more likely that future epochs, if there are any after we screw this one up, will remember us as a pampered people who squandered our bottomlessly rich scientific and financial heritage by willful ignorance of how it works.

Majoring in English is a fine thing to do. We need more good writers. But take an economics class, so when you write about the world, your elegant prose does not reflect complete ignorance about how that world works. You don't need to suffer equations. Reading Smith, Hayek, and Friedman will do.

30 comments:

FWIW, since the "cost of money" is part of Howard's P&L calculation, isn't comparing his returns to a 10% CD double counting? The 10% opportunity cost of the investment is the cost of money. Or are they referring to something else in the publishing world?

"We live in a time when college enrollment in the humanities is declining precipitously, in good part because majoring in such subjects seems unlikely to result in gainful employment in a strapped economy and thus would be a waste of hard-earned (or usuriously borrowed) tuition dollars."

I hate to pick on the poor fellow, but if I were his editor, I would object to "usuriously borrowed" on the basis that one can only commit usury by lending, not borrowing. But, I suppose I'm nitpicking a little bit of literary license.

Come to think of it, depositing those funds in the bank might have been a good means of ensuring that some worthy English major might be able to get a loan, "usurious" or not. I'm sure our author would agree that that would have been a very good "investment" indeed, even if (or especially if?) it were not applied to those economics credits.

That said, I think you may have misunderstood the "moral" of the little story that was told. The author admits ignorance with respect to the economics of banking and finance and I don't think that bothers him a bit. While he attempts to make a farcical economic case for his decision, I took that as a joke. The real "moral" of the story seems to be that willful ignorance in this instance is ok. After all, the perceived intangible, non-financial rewards of having those two little books published outweigh, in the author's mind, any tangible financial rewards of investing the funds rationally. From the point of view of the author, and presumably the author's NYT editor, this is not only a perfectly defensible point of view, it is the very point of the piece. The piece was not at all about logic; it was about emotion.

Yes, but there are non tangible rewards that the alternative users of the funds would have produced too. If they had the wit to imagine who else might have borrowed the money from the bank and what they would have done with it, emotion could have buttressed economic rationality.

Yes, that's true. I'm not defending the man's logic on the economic dissection of the problem; but, I can't help believe that even for economists the immediate satisfaction to oneself always outweighs the potential abstract satisfaction for others. The fact that humans act in their self interest is actually a fundamental tenet of behavioral economics, or not? Good literature demonstrates human nature and the supposedly non-fictional tale of one human's economic choice rings true here to me on that level. Perhaps we should read the story as a very accurate portrayal of the human comedy (or tragedy) rather than a story of textbook economics?

I presume it has occurred to you that the 10% CD's could have been funded solely by U. S. Treasury bonds - in essence taking tax revenue to make the 10% payments without any productive purpose being achieved by the borrower (federal government).

In fact I wonder if your criticism would be the same if the writer had said 1980-1984 vintage 10 year treasuries instead of CD's?

Or perhaps having the knowledge that money is put to a productive purpose doesn't jive with your thinking.

If only economics students did not have to suffer equations! But they do, and so the rest of us have to suffer through the economic ignorance of the English majors who were driven away from economics by equations.

Equations alone do not make falsifiable predictions, they just let you sound scientific. Equations with *measurable parameters and outcomes* make falsifiable predictions. Equations with free parameters like 'propensities' and 'tendencies' are known in physics as "not even wrong".

But, in the spirit of "tear apart my prose and push every little detail of fact and logic," you should admit--the Wall Street Journal regularly publishes some of the most insane, fact-challenged economic commentary on the planet. Don't get me wrong, they have some good stuff sometimes, but its clearly not because they have good editors.

Loans need to be risky if they are going to enable any real activity. To fund a typical bank asset you need a proportionate mix of risk-free funding and risk capital. It's the risk capital that's supposed to take all the risk, the deposits being "risk-free."

Bank capital rules reflect this, which is why an increase in deposits don't enable any increase in lending at all. The only exception, of course, is "lending" to the Fed. A new deposit also comes with an equivalent amount of reserves.

So the English major is right (or at least not wrong in the way you suggest): if the employer had put the money in the bank instead of paying him, nothing would have happened (if the fed did not pay IOR, the . He is wrong in another way though: if an economy is operating at capacity, there is no reason why paying someone for a service (useless or otherwise) should have any multiplier effect.

Okay, so everyone piled up on the obviously naive/economically incompetent English major. Fine. He deserves it.

OTOH, what kind of punishment should we dish out to Pr. Cochrane who is an economic professor and still get it wrong?

Banks invest money? Really? I thought they mostly gambled it on the markets or on spurious investment products - Try borrowing some money right now for a new small business venture and let me know how it goes.

Furthermore, if and when they do find a project they're happy to invest in, they don't have to tap the money left by savers - they can just create some.

Savings =/= investment, FFS! An economic professor, even a conservative one with a tendency to think in moralistic terms, should know that...

One of the greatest literary minds of the 20th century, Ezra Pound, spent his final decades preoccupied with monetary theory. Good writing is about saying something well AND having something to say. Thus, to the extent they misunderstand the world, the more it hurts their craft, because essays on phrenology and other wrong theories are boring.

Yet, there's a balance between facts cited without good relevancies and analogies, and relevancies and analogies applied without good facts. The extremes are always lamentable. The poets are good at analogies and metaphors, especially references to earlier classical literature; scientists are good at facts, but often don't have a good answer to 'so what?', because their finding is parochial to a class of models that has not proved useful, and never will.

That's a really stupid comment. Just because we don't know everything doesn't mean we don't know something. "A physics profession that can't really tell us what dark matter is should probably not be throwing intellectual stones" when some goofball gets F=MA wrong?

In effect you claim economists understand what happens when money gets deposited with a bank. But it is precisely the failure of economists to really understand banking and the market for money that brought us the financial crisis.

Absalon, maybe the most important lesson of economics is how little we know. If economists can't figure out what the most productive use for the labor, energy, and resources that go into print publishing is, what makes you think that some english major is going to figure it out? The purpose of capital markets is to incorporate both the economist's knowledge, and the author's knowledge in the allocation of those resources. If you don't think the current banking system is doing a very good job, then I wonder how you'd like to improve it--by further concentrating the allocation of resources with more rules? Or by decentralizing and liberalizing capital markets so that a handful of economists don't get to steer the fate of the economy?

Jason - The financial system has multiple problems. Sometimes really smart people just get blinded by the beauty of their equations (see Scholes, Merton and LTCM). Too often decisions are being made by people who are arrogant, stupid or dishonest or all three. Arrogance (Lehman Brothers), stupidity (AIG) and dishonesty (Country Wide) played large roles in the financial crisis.

If I were reforming the financial system I would start by legislating most of the derivatives markets out of existence since I believe that large risks and horrors still lie hidden in those markets. Next I would take steps so that anyone knowingly or recklessly producing misleading financial statements or prospectuses went to prison for a long time. The London Whale incident apparently resulted in misleading financial statements. The underlying transactions demonstrate arrogance and stupidity but misrepresenting the impact of the transactions on the financial statements was dishonest. Transparency and honesty will make the market more fair and more efficient.

I suppose the questions about JP Morgan and the Great Whale are whether its financial statements were intentionally misleading and whether they were materially misleading. Of course, neither of those questions have anything to do with whether derivatives are good or bad or whether we need a Volcker Rule or don't or whether dishonesty (fraud) was a material cause of the Financial Crisis (it wasn't) or whether regulation can rid the world of arrogance and greed (it can't). IMHO, moral hazard is the big problem in the financial system.

Gerald Howard here. I admit that at age thirty I was not very conversant with the workings of the banking industry. But now, at the advanced age of 62 I've learned quite a lot -- more than I ever wanted to. I know that banks like Chase and Citbank (with whom I bank) would have taken that $7500 and plowed it into risky mortgage bonds (not lent it to that immigrant hoping to open his restaurant -- please . . .) and thus have helped to precipitate a global financial crisis thatamong other malign effects reduced my retirement account by about 45%. Adam Smith wept.

Truthfully, I do wish that I had added an intro econ course into my promiscuous mix of courses in the liberal arts walkabout that was my college education in the late sixties and early seventies. I've been trying all my thinking life to figure out how the world actually works, and that would have been a great help. But the financial industry has given us all ample -- huge!- -reasons to be skeptical of its claims that what is good for it is good for us al, and I was making my modest and wry counterstatement t on behalf of the claims of culture.

Gerald: Thanks for writing, for identifying yourself, and graciously putting up with us economists poking fun at your article. I understand your main point was an ethical one, not really about economic policy. John Cochrane

My interpretation of Howard's article is that liberal arts provide a public good that is not priced in when calculating private returns (except perhaps when the editor cooks the books to ensure it is published). How much value to the world has Shakespeares provided? If there wasn't a market for his plays at the time (i.e. private returns weren't high enough) would the plays not exist and that value lost? However, the same could probably be said about all areas of study, including finance, but the liberal arts might be one of the most impacted.I think if Howard had taken Econ101 he could have made this point more clear, as I think it is a well understood issue.

It seems that the demand siders have taken the economizing out of economics. So obsessed they are with stimulating activity and consumption, they are willing to finance negative net present value projects via increased borrowing. Spending money to publish a book that won't sell is the same thing, economically, as building a bridge to nowhere, or digging a ditch to fill it up. It consumes capital, leaving less for future generations. Rather like breaking windows. Even bridges to nowhere have beneficiaries - politically connected contractrors. In this case, an author and a publisher get to enjoy the value-destroying activity.

I'm convinced that the best way to understand an economy is as the sum of its billions of projects. Just as a company is the sum of its hopefully net present value positive projects, a national economy is the sum of its personal and corporate projects. (for those who don't understand the concept, NPV can be learned in any Finance 101 course, I assume it's an alien concept to NY Times Nobel Winning Macroeconomists). Positive NPV projects are what creates an economic surplus allowing economies to grow over time. Negative NPV projects subtract from the economy. Spending $50,000 on an English degree to create a career with a net present value of $100,000 could be a good (not necessarily optimal) decision, particularly if English is something which provides enjoyment to the degree earner. On the other hand, spending $100,000 on the degree to create a career with a net present value of $50,000 is essentially squandering capital - hidden consumption (perhaps spending family or government money to do something fun rather than objectively useful to others within the economy).

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.

About Me and This Blog

This is a blog of news, views, and commentary, from a humorous free-market point of view. After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!